FBAR Violations Outside of the OVDI Program

Sep 06, 2017

This post explores the potential penalties that can a taxpayer can incur if they choose to come into compliance (i.e., by disclosing their offshore assets/accounts to the IRS) outside of the Offshore Voluntary Disclosure Initiative (aka Offshore Voluntary Disclosure Program). If the IRS has already obtained a taxpayer’s foreign account information from a foreign financial institution, he or she will likely be barred from entering one of the offshore voluntary disclosure programs (i.e., the streamlined OVDP or OVDP). In addition, there could be strategic reasons not to enter the program. If a taxpayer chooses to disclose foreign assets/accounts to the IRS without the protections of one of the voluntary disclosure programs available, the IRS will seek to determine whether the foreign account violations were willful and, if so, whether the case warrants criminal prosecution. Exploring Willful vs. Non-Willful Violations. Making the determination of whether a violation is willful versus non-willful is critical for predicting the assessment of civil penalties. Willful penalties, where the IRS finds that a taxpayer willfully evaded disclosing their foreign accounts and paying taxes on such, can be as high as the greater of $100,000 or 50% of the account value. This is in addition to back taxes, interest, and an accuracy penalty that is 20% (or in some cases 40%) of the back taxes owed. A non-willful violation generally calls for a penalty of up to $10,000 per year of violation for the years that remain open under the statute of limitation. In some cases, the IRS may agree to waive penalties altogether, though this appears to be rare. Next, the FBAR Wiz will explore what separates a willful violation from a non-willful violation. The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty (IRM §4.26.16.4.5.3.1). The IRS has the burden of establishing willfulness (IRM §4.26.16.4.5.3.3). Willfulness is shown by the person’s knowledge of the reporting requirements and conscious choice not to comply. In an FBAR situation, the only thing that a person needs to know is that he or she has a reporting requirement. If a person has that knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR (IRM §4.26.16.4.5.3.5). Several examples of what the IRS considers to be a willful violation can be found in IRM Section 4.26.16.4.5.3.8. While the standard of proof the IRS must meet to prove that an FBAR violation is willful formerly appeared to be one of clear and convincing evidence (see IRS Chief Counsel Advice (CCA) 200603026), the less strict preponderance-of-the-evidence standard was applied by the court in McBride, No. 2:09-cv-378 (D. Utah 2012). Willful violations are perhaps more likely to be found where the account owner put the funds in the account, used the funds in some manner, and actively participated in keeping the account hidden from the authorities. Nonwillful violations may more likely be found where the taxpayer did not put the funds in the account, exercised no control over the funds, did not use any of the funds, and was unaware of reporting requirements. Clearly, a large spectrum of behavior between these two extremes comes down to the facts and circumstances of a particular situation. Defending a client against the higher penalties associated with willfulness calls upon the practitioner’s skills and abilities. Can a taxpayer avoid the finding of a willful violation by claiming that he or she did not know about the foreign account filing requirements? For a time, it looked as if one district court was going in this direction (see Williams, No. 1:09-cv-437 (E.D. Va. 9/1/10)). On the government’s appeal, however, the Fourth Circuit held (Williams, 489 Fed. Appx. 655 (4th Cir. 2012)) that the district court had clearly erred in finding that Williams did not willfully violate 31 U.S.C. Section 5314, the federal law that requires individuals to report to the IRS annually any financial interests they have in any bank, securities, or other financial accounts in a foreign country. In the Williams case, the taxpayer, Bryan Williams, checked “no” on Schedule B, Section III, line 7a, and filed no FBARs. He claimed that he was unaware of the filing requirements and never read the actual words on his return. The Fourth Circuit found that the taxpayer made a conscious effort to avoid learning about the reporting requirements. The court found that signing his 2000 federal income tax return was prima facie evidence that the taxpayer knew the return’s contents. Williams’s false answers on both the tax organizer he filled out for his tax preparer and his income tax return further indicated conduct that was meant to conceal or mislead on sources of income or other financial information, the court found. In such a situation, “willful blindness” may be inferred, the court said, where “a defendant was subjectively aware of a high probability of the existence of a tax liability, and purposely avoided learning the facts” (quoting Poole, 640 F.3d 114, 122 (4th Cir. 2011)). According to the court, at a minimum, Williams’s actions established reckless conduct, which satisfied the preponderance-of-the-evidence burden of proof requirement for the civil FBAR penalty for willfulness. The McBride case similarly dealt with willfulness in the context of FBARs. The taxpayer, Jon McBride, had a company that was operating overseas. He retained the services of a firm that designed strategies to allow its clients to avoid reporting income and their ownership in assets by having its clients’ assets held by nominees holding legal title of shell corporations and foreign bank accounts. McBride accessed the funds through sham lines of credit. The district court found that McBride had an interest in foreign accounts and that he willfully failed to report his interest in them. By signing his returns, McBride was said to have imputed knowledge of the requirement to file FBARs, since the tax returns contained a plain instruction informing individuals that they have the duty to report their interest in any foreign financial or bank accounts held during the tax year. The court acknowledged that willful blindness satisfies a willfulness standard in both civil and criminal contexts. In McBride, the court also reasoned that the willfulness standard can be satisfied through the taxpayer’s reckless disregard of a statutory duty. Simply not knowing about the foreign account reporting requirements is not enough to defeat a finding of willfulness. The court noted in McBride that subjective knowledge was not required for the taxpayer to have willfully failed to comply with the FBAR requirements, because the taxpayer acted in reckless disregard of the known or obvious risks created by his involvement with foreign accounts. Drawing an analogy with the trust fund recovery penalty standards under Sec. 6672, the court stated that “a responsible person is reckless if he knew or should have known of a risk that the taxes were not being paid, had a reasonable opportunity to discover and remedy the problem, and yet failed to undertake reasonable efforts to ensure payment” (quoting Jenkins, 101 Fed. Cl. 122, 134 (2011)). In the Williams and McBride cases, the courts noted that both taxpayers failed to discuss their financial strategies involving millions of dollars with their accountants. This was viewed by the court as significant evidence of willfulness or at least recklessness and willful blindness. This is an important holding because it shows that merely signing your tax returns is sufficient to impute the "knowledge" requirement for a willful violation in certain circumstances. The potential penalties explored in this blog post highlight the importance of retaining an attorney that specializes in offshore disclosure work. You can get started for free by determining if you have offshore disclosure obligations (like filing the FBAR Form and Form 8938, for starters) by checking out the free FBAR Wiz app here.